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portfolio’s carbon footprint. This additional
objective induces a trade-off between effective
decarbonisation and efficient portfolio return
replication. The concentration of high-carbon-
footprint securities across a small number of
sectors makes the return-replication objective
particularly challenging.
In our analysis, we looked at four approaches
and assessed their investment results in achieving
these (potentially) conflicting objectives, while
remaining consistent with the values outlined
in the Montréal Pledge and by the Portfolio
Decarbonisation Coalition.
PORTFOLIO CONSTRUCTION STRATEGIES
1. Divestment: To aggregate the carbon
footprint, this strategy removes the 120
highest contributors and re-weights the
portfolio on a pro-rata basis.
2. Sector Neutral Reallocation: This strategy
is similar to Divestment, but without the
sector deviations. The investor removes
the highest-carbon-footprint securities in a
sector (for example the 60th percentile and
above) and then, to maintain sector weight,
re-weights the securities within the sector on
a pro-rata basis.
3. Risk Model Optimisation: This strategy
uses a risk model–based optimisation that
seeks to minimise the carbon footprint while
keeping ex-ante tracking error at less than
30 basis points. It also incorporates active
weight constraints at the security, sector and
country level.
4. The Russell Investments Decarbonisation
Strategy: This strategy is a hybrid of the
three approaches described above. It aims to
preserve the strengths of all the approaches
and minimise the biases. While investors
are looking to encourage decarbonisation,
they still have a fiduciary commitment to
deliver on return expectations. This strategy
emphasises a divestment approach while
also incorporating security, sector and
country constraints to effectively manage
active risk and ensure that fiduciary
obligations are met. It aims to achieve a 50
per cent reduction in the carbon footprint
while minimising the active share of the
portfolio relative to the benchmark, as
opposed to minimising forecasted active risk.
To evaluate different approaches we have
centered on a common investment objective
for many asset owners in this space: generate
a benchmark-like return while keeping the
carbon footprint of the portfolio below a
specified level relative to the benchmark. For
consistency and transparency, we have defined
the benchmark for all the strategies as being the
MSCI ACWI and the required carbon footprint
level as being 50 per cent of this index.
THE FOLLOWING TABLE SUMMARISES THE KEY METRICS OF EACH APPROACH
Source: Russell Investments, MSCI and Trucost as of 31 December 2015.
METRIC
ACWI
DIVESTMENT
SECTOR NEUTRAL
REALLOCATION
RISK MODEL
OPTIMISATION
RUSSELL
INVESTMENTS
DECARBONISATION
Annualised Return
8.96%
9.92%
9.38%
9.65%
9.35%
Annualised Volatility
13.63%
13.59%
13.92%
13.74%
13.74%
Annualised Tracking Error
-
0.83%
0.91%
0.44%
0.37%
Maximum Active Drawdown
-
-1 .19%
-1 .37%
-0 .82%
- 0.49%
Annualised 1-Way Turnover
9%
10%
16%
25%
11%
Name Count
2444
2318
1389
1632
1637
Active Share
17%
41%
25%
12%
Aggregate Carbon Footprint as a
Percentage of ACWI
46%
45%
29%
47%
Superfunds June 2016